A recent opinion article by Graeme Edwards on the NBR site clearly articulated a critique of the emissions trading scheme that I have heard in various forms over the past year. Not only have I heard this critique from politicians and the media, but people commenting on the blog and other economists have used this critique. As a result, it is important to point out why this critique is simply wrong.

The critique is simply that the emissions trading scheme is a “scam” because global warming is not the result of carbon emissions.

Even if we agreed with this view the critique is still wrong. The reason this critique is wrongheaded is simple – the ETS is not supposed to prevent global warming, it is supposed to raise funds to pay for/reduce a liability we owe thanks to the Kyoto protocal. Now that we are in the Kyoto protocal, we want to look at two simple choices – what is the cost if we stay in, and what is the cost if we leave? The ETS was determined to be the least cost way of paying for the liability if we stayed in the scheme, and it was also determined to be of a lower cost than leaving the scheme (relative to losing international prestige and possible new trade barriers if we leave).

As a result, even if it was true that man wasn’t warming the planet with carbon introducing an ETS is still the best policy – as long as we believe that it is of a lower cost than these other potential options. The debate should lie with the cost of different options – whether global warming actually exists is irrelevant.

“So even if man-made climate change is rubbish we should keep introducing a measure to reduce carbon emissions?! ”

Yes – as our liability is still based on carbon emissions. If we owe money when we do something then we should figure out the cheapest way of paying off this liability – instead of having a whine about how we don’t think the liability is fair.

goonix

If that was really the case (man-made climate change was rubbish) then I think it would be much less costly to simply ditch the agreement. I can’t see how running a scheme would possibly be less costly than “losing international prestige and possible new trade barriers”, particularly if others then realised it was a scam.

“If that was really the case (man-made climate change was rubbish) then I think it would be much less costly to simply ditch the agreement”

Actually, even if climate change was real then we have the same choice – as New Zealands carbon emissions are so small and insignificant in the grand scheme of things that our choice of emissions does not impact on the probability of a global warming event.

As a result, if we believe that it would be cheaper to dump the agreement – then we should do that, regardless of whether global warming was real. However, this is not the conclusion that government has come to – given that the European nations have threatened to put sizable tariffs on any countries who leave the Kyoto protocol.

goonix

But if we were the among first to ‘discover’ the emperor’s new clothes weren’t real and accordingly ditched Kyoto, we might face some costs (i.e. trade with Europe) but they could still very well be less than the costs of implementing a trading scheme. My point is that, as others also will ‘discover’ what we have, the costs of not implementing a scheme will diminish (pretty swiftly I would think too).

“But if we were the among first to ‘discover’ the emperor’s new clothes weren’t real and accordingly ditched Kyoto, we might face some costs (i.e. trade with Europe) but they could still very well be less than the costs of implementing a trading scheme”

I agree with this point – if we did think that the scheme would have a definite end it could well be cheaper. However, I am pretty sure that the government did do some costing of the scheme as though it ended in 2012 and still believed that an ETS was more appropriate.

Ultimately our best response does depend on what we think other countries will do – and that is all we should care about. If we think other countries will call off the Kyoto liability then we should ignore it – but if we think they are going to stick to it, even for a relatively short-time period, the government has determined that the ETS is the least cost option.

The argument that we should have the ETS because global warming doesn’t exist is not only contentious from a scientific standpoint – it is poor analysis from an economic standpoint

George Bolwing

Brave of you to venture into the vexed world of the ETS.

This is an area where rational analysis is too often drowned-out by rhetoric and polemic from all sides. Indeed, the “debate” is often categorised as only having two sides – that climate change is an eminent disaster of biblical proportions or is a scam – when it is really a subtle and multi-faceted area, involving science, economics, politics, engineering and many other fields.

What is often missing from debates is a good analysis of risk. Too often, statements are made as if outcomes are certain.

The IPCC reports are very clear that there is considerable uncertainty (in the Frank Knight sense of unknown probabilities) around expected outcomes.

Given this, we should not be proceeding on the basis that we have a binary choice (climate change is real or not real), but how to make decisions on the basis of extreme uncertainty around potentially extreme outcomes.

Put in more traditionally economic terms, what is the expected value of an event when the probability tends to zero, while the cost tends to positive infinity? How much should we be prepared to pay to avoid this event, when there is also uncertainty around both the cost and efficacy of the insurance?

My view, for what it is worth, is that we enough about the possible consequences of climate change for it to be prudent for there to be less greenhouse gases than at present in the atmosphere. How much less and how quickly we should be looking to stabilise concentrations are still open questions.

Moving to the issue of the ETS itself, not only is it about the least cost method of meeting our international obligations, it is also about how we can encourage and support international efforts to address the risks of climate change. So while it is true that New Zealand’s efforts alone cannot address the risks of climate change, we are not alone. The risks cannot only be address by concerted international efforts, from both developed and developing countries. So what New Zealand needs to do is act domestically in a way that encourages other countries, especially in the developing world, to also act to address the risks.

Gareth

An excellent point and one that I’m amazed keeps getting ignored. TVNZ7’s news show last night had someone from the Business Council for Sustainable Development bringing up similar issues and the newsreader actually said at one point “all the coverage seems to assume that by delaying the ETS we’re delaying the cost, but really we’re just loading it on the taxpayer aren’t we?”. How that hasn’t always been the main thrust of the media coverage I don’t know.

And Mr Bolwing, an excellent use of Knightian uncertainty =) The initial National Interest Analysis done for us on joining Kyoto was partly based around how our prosperity is relatively dependent on a stable climate, given our exposure to primary production and the like. The uncertainty of what climate change may do to that was a significant part of the thinking behind that. Of course, they also thought we were in for an economic windfall from post-1990 forestry unit sales, which didn’t pan out so well…

Canada abandoned Kyoto. There’s been zero international sanction or penalty. We ought quit scaring ourselves about retribution and flattering ourselves about the effect we have on other folks’ commitment to the system. End it now.

“Moving to the issue of the ETS itself, not only is it about the least cost method of meeting our international obligations, it is also about how we can encourage and support international efforts to address the risks of climate change”

I do not think this is a reason why we should implement an ETS ahead of other methods (tax, direct regulation) – I think this is part of the reason why we may want to join the Kyoto protocol even though it costs us, and part of the reason why we may not wish to renege on the deal. Once we are part of the protocol the issue of “cost” is the driver behind the choice of an ETS.

Hi Gareth,

“How that hasn’t always been the main thrust of the media coverage I don’t know.”

I agree – it is crazy, someone has to pay. If we don’t pay with an ETS the taxpayer pays – I’m not happy with that.

Hi Eric and Gareth,

“Canada abandoned Kyoto. There’s been zero international sanction or penalty.”

“Eric, note that Canada have NOT withdrawn from Kyoto.”

I don’t know whether Canada has or not but I think this all raises an important question.

If Canada did or could leave Kyoto without sanction, why? How trade exposed are they to Europe (who are the main people threatening to impose sanctions?).

If Canada did leave with no repercussions it does not necessarily mean that we won’t be hit if we leave – after all we trade with different people and have a different bargaining position. The cost of leaving the agreement should be dealt with in policy analysis – I do not think that we can act like the cost is zero or infinite.

Matt

Emissions trading was criticized in a study (I never keep references! what a bum!) which showed that income from emissions drecits would simply go to the general fund and be used to fund government without regard to government efficiency in energy use.

“Emissions trading was criticized in a study (I never keep references! what a bum!) which showed that income from emissions drecits would simply go to the general fund and be used to fund government without regard to government efficiency in energy use.”

The purpose of the ETS is the create funds to pay off a liability by making those who create the liability pay for it. Anything that states that the scheme will just take the money and spend it on other things is not a study – it is an assumption.

George Bolwing

Two points:

Canada is still a party to the Kyoto Protocol, but its emission levels are well ahead of its obligations (its Kyoto target is to be at 94% of 1990 emissions over the 2008-12 period, and the report out yesterday had its 2006 emissions at 154% of the 1990 baseline). Their domestic policy is a complete muddle, made worse by an infestation of beetles that are destroying large tracts of forests. It is unclear what they are going to do.

On revenue recycling, the economic literature favours market instruments like emissions trading and carbon taxes because they produce a “double dividend”: they correct a market failure and generate revenue that can be used to reduce other, distorting, taxes. But in reality, governments are not so pure and tend to (a) put in place instruments that don’t (fully) correct market failures and (b) use the revenue to fund further programmes that create further distortions. This is one of the National Party’s criticisms of the New Zealand ETS: that it is not revenue neutral.

“Their domestic policy is a complete muddle, made worse by an infestation of beetles that are destroying large tracts of forests. It is unclear what they are going to do.”

Very interesting.

“This is one of the National Party’s criticisms of the New Zealand ETS: that it is not revenue neutral”

And it is a fair criticism if the policy is not revenue neutral – however it is not a criticism of emissions trading in of itself as the comment was stating.

As you say, if we could replace income taxes with externality taxes without hammering up compliance costs it appears to be a no-brainier 🙂

Gareth

Smart revenue recycling is something I’m all for. The creation of a “ClimateCo” standalone unit of the MoE and Treasury that administers, receives and keeps a carbon tax, and is the body responsible for meeting our Kyoto commitments (and beyond) is superficially attractive (although I’m not deep enough in the detail to really compare it other methods). All “carbon-money” could then go to emission-reduction programs, incentives and R&D and obviously any payment of an excess over obligation. Keep it out of the general fund and focussed purely on minimising the obligation…

Of course that’s a huge deviation from current ETS thinking and I’d much prefer we just got on with SOMETHING that exposed the creators of our liability to at least some of that cost…

(Thanks for the blog by the way Matt, and the chance to have a decent level of discussion over this stuff).

“All “carbon-money” could then go to emission-reduction programs, incentives and R&D and obviously any payment of an excess over obligation. Keep it out of the general fund and focussed purely on minimising the obligation”

In practical terms that makes sense. Of course if the government could commit to an exogenous level of spending, then it would be fine to use the funds to reduce income taxes 🙂

“Thanks for the blog by the way Matt, and the chance to have a decent level of discussion over this stuff”

No worries, it is the comments from you guys that add most of the value anyway 😉